Textbook Notes (367,823)
Canada (161,434)
Economics (728)
ECON 1BB3 (332)
Chapter 13

econ chap 13 notes.docx

5 Pages
Unlock Document

Bridget O' Shaughnessy

Chapter 13 A macroeconomic theory of the open economy Learning objectives  Build model to explain an open economy’s trade balance and exchange rate o Analyze effects of government budget deficits o Analyze macroeconomic effects of trade policies o Analyze political instability and capital flight Net capital outflow: flow of loanable funds abroad Market for foreign-currency exchange coordinates people who want to exchange the domestic currency for the currency of other countries The market for loanable funds  All savers go to this market to deposit savings, and all borrowers get their loans here  There is one interest ratereturn to saving and cost of borrowing  S = I + NCO  Saving = domestic investment + net capital outflow  In an open economy, national savings does not have to equal domestic investment  If saving is insufficient to buy domestic capital, the shortfall can be met by savings of foreigners o NCO is negative  Demand for loanable funds comes from domestic investment (I)  Real interest rate determines quantity of loanable funds supplied and demanded o Higher real interest rate, more people save, more supply o Higher interest rate also makes borrowing more costly, less demand, discourage investment  In a small open economy with perfect capital mobilitywe ignore differences in tax treatments and default risk r= rw  In a small open economy, we need to include savings of foreigners  When S is able to satisfy domestic I, the excess money supply can then use to buy foreign assets  The excess money is NCO  If S is unable to satisfy domestic I, the excess demand for loanable funds be gained from foreign investors (capital inflow)  Interest rate in open economy is determined by world interest rate (r = rw)  Ex: want to buy Japanese government bondmust first exchange CAD to yenssupplies dollars in a market for foreign-currency exchange  Net exports = quantity of dollars demanded for buying Canadian net exports of goods and services  If Japan wants to buy planes made my Canada, it must first DEMAND dollars in the market for foreign-currency exchange  Real exchange rate: balances supply and demand in the market for foreign exchange rate o Relative price of domestic and foreign goods o Key determinant of net exports o High real exchange rategoods become more expensiveless exports o Appreciation in real exchange rate means reducing quantity of dollars demanded in the market for foreign-currency exchange RER equilibrium s equilibrium quantity D  Net capital outflow does not depend on exchange rate  Higher exchange value of CAD make foreign goods less expensive for Canadian buyers, and makes foreign assets less expensive o But Canadian investors eventually want to turn foreign assets back to CAD  Changes in exchange rate influence both cost of buying and benefit of owning foreign assets o Offset each other  Equilibrium real exchange rate: demand for dollars to buy net exports balances supply of dollars to be exchanged into foreign currency to buy assets abroad  Ex. Canadian residents buys car imported from japandecrease in quantity of money demanded due to fall in net export  Ex. Japanese buys Canadian bond decrease in quantity of dollars supplied due to fall in net capital outflow Net capital outflow: link between two markets  In market for foreign-currency exchange, supply comes from net capital outflow, demand comes from net exports, real exchange rate balances supply and demand  The real exchange rate does
More Less

Related notes for ECON 1BB3

Log In


Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.